Have high yield ETFs created liquidity risk?

Tom Eckett

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Analysts have always cautioned against investing in ETFs in traditionally less liquid segments of the markets due to the risk of bid-ask spreads widening further than the underlying assets.

In a recent research note, MSCI studied the impact of ETF redemptions on the wider high yield market to see if there are these liquidity risks. In particular, the index provider measured the impact of high yield ETF redemptions in Q4 last year.

According to data from IHS Markit, ETFs account for around 2.7% (or $34bn) of the total high yield bond market, which has a daily average trading volume of $7bn.

In Q4 2018, redemptions of high yield ETFs soared to around 25% of these funds’ assets under management (AUM).

MSCI focused on four days – 8 October, 10 October, 14 November and 21 December – when net redemptions of high yield ETFs exceeded 4.5% of AUM, to see if the bid-ask spread widened specifically due to ETF redemptions.

It found on three days, there was minimal difference in bid-ask impact between ETF and non-ETF constituents while on 21 December the bid-ask difference narrowed moderately.

Reka Janosik, vice president, risk management and liquidity core research at MSCI, commented: ”If ETF redemptions did result in significant liquidity deterioration, we would expect the ETF constituents to experience more bid-ask widening than the non-constituents during periods with large amounts of redemptions.

“Heavy redemptions of high-yield ETFs during Q4 do not appear to have had a large impact on the constituent bonds’ bid-ask spreads,” she continued. “On balance, we interpret the data as suggesting that redemptions did not generally result in impaired liquidity in the high-yield-bond market.”

Despite this however, Janosik warned investors should continue to pay attention to ETF redemption levels in the high yield market as redemption spikes could have an impact on bond-market liquidity during “highly stressed conditions”.

Fixed income specialist Tabula launches high yield ETF

BlackRock manage the largest high yield ETF listed in Europe, the €6bn iShares Euro High Yield Corp Bond UCITS ETF.

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